Leases

1. Leases

2. The signing of a lease represents a significant financial commitment.Because hiring legal counsel to negotiate a lease is prohibitively expensive, the negotiations are conducted by the parties.Thus it is necessary for the lessee (you) to understand the terms of the lease offered by the lessor (landlord).

3. In optometry, there are two types of leases that are most commonly employed.Office leases are long-term agreements forspace in which to practice.Equipment leasescan be used as asubstitute for the purchase of ophthalmic instruments and equipment.

4. Office Leases

5. What are key features of a leased office? • Visibility—the location is easily observed by automotive traffic • Parking—convenient access to the office, including parking, is important • Accessibility—there should be easy entry to the office for handicapped individuals • Efficient floor plan—with one examination room, patients are moved to and from the room; with two or more examination rooms, the doctor moves between rooms

6. How much space is needed for an optometry office? • Small offices are less than 1,000 square feet • Moderate offices are 1,000 to 2,500 square feet* • Large offices are 2,500 to 6,000 (or more) square feet *Moderate sized offices usually include a second examination room, contact lens area, larger laboratory, a data collection (workup) room, a second bathroom, and a private office for the doctor.

7. What should an office lease cost? • AOA Economic Surveys indicate that lease cost should be between 6% and 7% of gross income • The most expensive leases are usually in commercial properties such as malls • On a square foot basis, cost varies between communities (larger communities cost more), and an internet search shows that Birmingham office costs range from $9 to $24 per square foot

8. Office leases are negotiable: • The terms offered in a lease should be considered subject to negotiation—if the lessor exhibits a “take it or leave it” attitude, the latter option should be chosen • Professional counsel should be solicited to ensure understanding of and to propose modifications to the lease • The lessee has the power to accept or reject the lease—and to obtain concessions before signing

9. During the period between signing the lease and beginning to see patients, the lessee can offset the loss of income by: • Asking the lessor to excuse or reduce rent to lower overhead expenditures while alterations are being performed on the premises or equipment is being delivered and installed • Negotiating payment by the lessor for all or part of the alterations or improvements to the office • Obtaining a “step-up” lease, in which rent is paid at a reduced rate for the first 6 to 12 months and gradually increases to the full rate over time

10. Lease provisions should be carefully read and fully understood before signing. • Identification of parties—if a lease is signed by a representative of the business organization involved (“John O’Dee, as agent for Birmingham Eyecare, PC”), it is the organization rather than the individual practitioner that is responsible for payment • Property description—important because this is the property on which taxes will be levied, insurance must be purchased, maintenance will be paid, and so forth

11. A key provision of office leases is the term: • Term—a long-term lease is preferred if it is affordable and the location is desirable; 3 to 5 years would be considered ideal, 10 years would be appropriate only if a location was “perfect” • Renewal—the option to renew for additional periods is a valuable provision for the lessee; the rent to be paid during the renewal term should be determined on a pre-renewal basis and included in the lease

12. The rent to be paid is one of the most important lease provisions: • A net lease implies that the lessee will pay the lessor rent that includes the “net” cost of all taxes, insurance, or maintenance expenses (i.e., the lessee pays these in addition to rent) • A gross lease implies that the lessor will pay the expenses for taxes, insurance, and maintenance out of the rent proceeds. • A negotiated lease should be a compromise between these extremes

13. Terms for “net” leases: • Most net leases establish a base or fixed rent (often called “minimum rent”); to which additional amounts are added for operating costs, such as taxes, insurance, or common area maintenance (e.g., landscaping, janitorial services, elevator upkeep, parking lot resurfacing, common area lighting) • “Caps”—maximums on these additional operating costs—should be written into the contract, or the contract should specify that the total expenses reimbursed to the lessor by all lessees will not exceed 100% of the actual costs incurred

14. Rent costs should be analyzed: • Is the “per square foot” cost in line with what is being charged for comparable offices in the vicinity? • The total cost for rent should be in line with national norms for optometry practices (6% to 7% of gross income). • The cost-per-square-foot should be applied only to the office’s actual floor space and should not include a prorated share of the building’s common footage, such as halls and lobbies

15. To determine the affordability of a lease, a pro forma analysis can be performed: • Gross income $500,000 less • Variable expenses (lab) $165,000 (33%) • Operating fixed expenses $150,000 (30%) • Net income needed $155,000 (31%) total costs $470,000 • Office lease should not exceed $30,000 (6%)

16. Rent increases, if allowed, should be limited: • If rent can be raised to allow for rises in property taxes, maintenance costs, or the cost-of-living index, annual increases should be limited to a maximum fixed percentage • Late charges should be clearly stated; the amount of any penalty and the date by which the penalty would be incurred need to be fully described

17. To prevent a significant increase in rent at renewal of the lease: • if a renewal option is included in the lease, if possible the rent increase or rent payment during the renewal term should be specified • the past history of the lessor should be determined before signing a lease—for example, has the lessor greatly increased rent charges for other lessees at renewal of the lease?

18. “Security” deposits are often required in lease agreements: • Payment of 1 or 2 months’ rent may be required • This payment will earn the lessor interest as long as it is held; unless the law requires it, the lessor will not offer to pay this interest to the lessee • The lessee can ask for payment of interest earned by the deposit

19. Tenant mix is an important provision in a multi-tenant building: • A clause may be included in the lease, prohibiting the lessor from offering leases or subleases to competitors (such as other optometrists or opticians) • The lease may also contain a clause preventing the lessor from renting to undesirable tenants (e.g., bars, pawn shops, massage parlors)

20. The option to sub-let or assign the lease to another lessee is also a desirable provision: • Most leases do not permit a lessee to sublet the leased premises • A reasonable compromise is to permit the premises to be sublet by the lessee, but with the agreement and approval of the lessor • If the individual subletting the premises defaults in rent, the original lessee remains responsible for payment

21. A necessary provision involves termination of the lease under certain circumstances: • In the case of death or disability, it should be possible to terminate the lease when the appropriate notice is given (e.g., 90 days) • If the office space is damaged by fire, water, or other casualty, and cannot be restored to service within a reasonable period (e.g., 90 days), the lessee should be allowed to terminate the lease • Both lessor and lessee should have the right to terminate or cancel the lease should the other party significantly default on lease provisions

22. Maintenance is a key provision of the lease agreement: • Maintenance provisions are subject to negotiation, and agreements can vary considerably, depending on the amount of rent paid and the length of the lease term • A negotiable compromise is for the lessor to be responsible for all repairs to the building exterior, including roof and exterior glass, as well as mechanical systems such as central heating and air conditioning, while the tenant is responsible for repairs to plumbing, the electrical system, interior painting, carpeting, and so forth

23. Insurance is a necessary provision for both parties: • Insurance on the building is normally carried by the lessor, who has the burden of rebuilding in the case of destruction by fire or other casualty • The lessee should be adequately insured for the replacement of interior leasehold improvements, furniture, equipment, and supplies

24. A requirement that the lessor provide notice of lease violations should be included in the lease: • Eviction should not be permitted the first time a lease provision is violated; written notice of violation of a rule should be required, and a reasonable opportunity to correct the error should be allowed • The lease should not contain a clause stating that a violation renders the lessee responsible for the payment of the rent for the balance of the lease

25. Alterations or improvements to the lease premises are usually necessary and should be negotiated: • Payment for renovations or alterations can be substantial • The lessee may find it necessary to offer to pay a higher rent than requested if, in return, the lessor agrees to absorb the cost of renovations • The lessee should try not to accept any clause requiring the premises to be restored to their original condition; improvements are assets to the lessor and should not have to be removed.

26. Lease agreements usually include an exculpation clause for the lessor: • An exculpation clause limits the liability of a lessor to the interest in the property itself • This clause is used to insulate the lessor from legal responsibility for certain acts—committed by the lessee—that cause injury to persons on the premises • Liability insurance coverage is used by the lessee to provide protection against such claims

27. Other important terms can involve parking and signage: • The lease should not require additional costs for parking • Parking privileges available to staff and patients should be specified • Parking should be available during the hours the practice is to be open; ideally, there should be 7 to 8 parking spaces for each professional in a building, but if the practitioner and staff do not use the spaces, a minimum of 4 to 5 spaces might be adequate • The lessee should be sure that the lease allows customary signs to be erected—both inside and outside the building

28. Office lease negotiations should be prepared for: • Tenants of the building should be consulted to determine the integrity of a lessor • The law of supply and demand governs a lessee’s bargaining position: bargaining strength depends on how badly a lessee wants the space and how much he or she is willing to pay for it; if there are other prospective locations and time is not of the essence, a lessee is in a better position to bargain • In low-to-moderate cost premises, the demand for space usually exceeds the supply; in more expensive areas, the reverse is true • Being a professional is in a lessee’s favor when bargaining--lessors would prefer to have a professional as a tenant, and a young professional should not be hesitant to ask for changes and concessions

29. Commercial lease agreements are different: • the usual leaseis 10% of gross monthly income (for a $530,000 gross that is $53,000 annually) • an income report must be submitted to the lessor by the 10th of the month, and if it is late a 5% penalty is imposed, based on the amount due, and also 10% interest until the amount is paid • the lessor has the right to enter the premises to inspect financial records “at any time and for any or no reason” • the lessor can order an audit of the financial records, and if an underpayment of 3.5% or more is found, the lessee must pay the deficiency and the cost of the audit

30. Very different: • the office premises have to be accepted “as is”; so also must the equipment provided by lessor • the lessee has to work the hours designated by the lessor (48 hours/week, including Saturdays) • the fees charged for services must be “equal to or preferably below” those in the “market area” • the lease can be terminated on 30 days’ notice • the lessee cannot sublease the premises (hire substitutes) without the approval of the lessor • the lessee has to purchase malpractice, other liability, property and premises insurance

31. Very, very different: • the lessor must be reimbursed for any damages paid by lessor because of a legal claim or judgment (such as from a malpractice case) • the lessee must waive the right to a jury trial if there is a legal dispute involving the lease agreement • at termination of the lease, the lessee may be required to “deliver complete copies of all patient records and files…to any licensed optometrist lessor may designate” • the lessee must agree to a non-compete clause at termination (1 year, 5 miles from any “competitive location”) • and the clinical space involved is about 450 sq ft (which costs over $100 per square foot!)

32. Equipment Leases

33. Equipment leases may be preferable to buying—such as when an optometrist does not wish to borrow money to purchase the equipment or chooses to use the capital for another purpose (e.g., buying a house). However, leasing ophthalmic equipment is typically more expensive than buying it.

34. The usual terms of an equipment lease arrangement are as follows: • the practitioner chooses the equipment, the lessor provides the money to purchase it • the lease term is a set number of years (usually 4 to 5) • the lease payment is a set amount, paid monthly • at the end of the term, the equipment is returned to the lessor • or the lessee may purchase the equipment

35. Advantages of leasing equipment include: • 100% financing of the equipment • no down payment • 100% of the lease cost is tax deductible • the equipment can be returned to the lessor after the lease term is ended • fluctuating interest rates do not affect the monthly payment

36. Disadvantages of leasing include: • the cost is greater than purchasing the equipment • the tax deduction may not be particularly helpful to a young practitioner • to purchase the equipment at the end of the lease term, an additional payment must be made (usually 10% to 15% of fair market value) • a default in payment obligates the practitioner to pay the balance due (acceleration clause) • insurance must be maintained by the practitioner • repairs not under warranty must be paid by the practitioner

37. As with other types of leases, it is always best to consult legal counsel before signing the contractDefault on lease payments creates the same legal difficulties as default on a bank loan; thus, the affordability of a lease arrangement must be given due consideration

38. “If you’re looking for a new lease on life—look somewhere else.”